The desire to solve society’s wicked problems is a primary motivator for both government and not-for-profit organisations, and has become an important driver for business as they refine their strategies relating to corporate social responsibility.

Individuals also share this desire and it is often the catalyst for philanthropy and volunteering. Individuals have also been able to respond to some societal problems by becoming ethical consumers or ethical investors.

But until recently ethical investors have relied on “screening out” investments which are bad for society rather than “screening in” investments which generate benefits to society, for example by investing in community wind power.

An innovative financial investment mechanism – the Social Impact Bond (SIB) – is currently being tested in the United Kingdom to see if it can harness not only this shared desire but also the changes in business strategies and individual behaviours.

A SIB restructures the traditional relationships between government agencies, not-for-profit (NFP) organisations and investors. Under a SIB, a bond-issuing organisation raises capital from investors based on a contract with government to deliver improved social outcomes that generate future government costs savings. These savings are used to pay investors a reward in addition to the repayment of the principal, if the agreed outcomes are achieved.

SIBs have a number of key attributes. Firstly, through a SIB government pays for the achievement of long-term successful outcomes rather than the current reliance on contractual arrangements which focus on short-term inputs and outputs.

Secondly, NFPs receive capital up front and, subject to achieving targets, have long-term financing. Thirdly, investors are able to achieve blended value where they receive both financial and social returns on their investment.

Finally, SIBs are heavily dependent on evidence of the efficacy of a selected intervention and the detailed measurement of costs and benefits – which then feature in the outcome-based contractual relationships between government and the host NFP, and the NFP and investors.

It is important to note that it is the repayment of the principal and reward payment from future government costs savings that differentiates social impact bonds from social or charity bonds.

Social and charity bonds adopt a traditional structure whereby the repayment of the principal and reward payments are funded by the cashflow in to the bond from fees received from operating activities. This type of bond has been successfully used for some time in the field of social housing where tenant rental payments are used to repay bonds for the building of new social housing stock.

SIBs can also be compared to Public Private Partnerships (PPPs) which have been used in many jurisdictions over the past 20 years to fund investments in “hard” infrastructure such as building toll roads and hospital buildings.

PPPs have evolved as government, business and investors increased their understanding of how this collaborative mechanism works – some of this understanding being the product of failure.

PPPs have been subject to considerable academic research and many robust evaluations, it is therefore important that the learning from PPPs is utilizsed as SIBs are developed and tested to see if such a collaborative mechanism will work in the “softer” world of social problems.

A social finance intermediary – Social Finance UK – has pioneered this new approach and established the first SIB in March 2010.

The purpose of the SIB was to significantly reduce the rate of reoffending by three thousand short-sentence prisoners at Peterborough Prison through a range of services delivered by several NFPs, which, if successful, will lead to significant future cost savings for the Ministry of Justice.

The SIB raised

5 million of capital from predominantly UK charitable trusts and foundations. The SIB will run for 6 years and the first payments will be made as the bond reaches mid-term.

There is considerable worldwide interest in the potential for SIBs. The Centre for Social Impact (CSI) has recently completed a feasibility study in New South Wales (NSW) commissioned by the NSW Government which identified viable SIB propositions in a range of policy areas including juvenile reoffending and families at risk. In the United States of America President Obama has announced USD100 million to pilot the use of SIBs.

Social Finance UK and the Young Foundation are actively encouraging and assessing the feasibility of SIB propositions in a wide range of policy areas, and at different levels of government including collaboration across levels of government.

The Nonprofit Finance Fund is pursuing similar initiatives across the USA. These efforts are supported by other key bodies that have a strong track record in promoting social innovation including the BIG Lottery in the UK and Rockefeller Foundation in the USA.

A successful SIB should be an optimal arrangement that satisfies the upside goals and downside risks of all three main stakeholders – government, NFPs and social investors. SIBs have the potential to increase the scale of resources available to NFPs. The reliance on evidence and detailed measurement may also lead to the better allocation of the resources of government and social investors. However, the ultimate test is whether SIBs do break the cycle and fundamentally change peoples’ lives for the better.